American seniors can take equity out of their homes without moving. They also don’t have to make payments during their lifetimes while they live in their homes.
Reverse mortgages were almost unknown when I first wrote about them more than a decade ago. Now, they are much better known but are greatly misunderstood.
Only 8,200 reverse mortgages were made in 2001. In 2005, over 40,000 are likely to be made. Not only is the number of mortgages growing, but the way the loans are used also is changing.
Reverse mortgages were a small backwater of the lending industry until 1989. That is when the federal government began insuring reverse mortgages up to a certain amount, which is tied to the median income in the homeowner’s area. To qualify for the guarantee, the homeowners must be at least age 62 and must meet with a certified counselor before taking the mortgage.
In a reverse mortgage, a homeowner borrows against home equity. The loan can be received in a lump sum, as a series of regular payments, or as a line of credit. In recent years, the line of credit has become the most popular form of the loan.
No payments are due until the homeowner moves, sells the home, or passes away. Then, the debt must be paid in full. While the loan is outstanding, interest accrues and increases the loan balance. In addition, the fees and costs of the loan often are added to the loan balance and paid only when the rest of the loan is paid. The homeowner is required to stay current on insurance and real estate tax payments and is not allowed to declare bankruptcy. Since the payments to the homeowner are loans, the payments are not considered income. They are tax free and do not affect Social Security benefits or other payments.
The lender can seek payment only from the home equity and the government guarantee. Because the home is the only backing for the loan, often no credit check is required.
The borrower and his estate are not liable if the outstanding balance exceeds the value of the home. That is why you will not be able to borrow the full equity in your home. The amount you can borrow will depend on your age, the value of the home, and current interest rates.
For example, according to an AARP estimate, when the interest rate is 6% and a home has a $250,000 value, a 65-year-old homeowner can borrow $130,757. An 80-year-old homeowner can borrow $169,204. The lender uses the borrower’s life expectancy to determine the amount of the loan so that the loan plus compounded interest and fees is not likely to exceed the home’s value during the borrower’s life.
The reverse mortgage lets the older homeowner accomplish an important goal. The homeowner uses the home equity without having to leave his or her long time residence.
Reverse mortgages were developed to help older homeowners in financial distress. An annuity loan could be used to supplement income which lost its purchasing power because of inflation. Or a lump sum loan could be used to make needed home repairs or to pay for a financial emergency such as medical or nursing home expenses.
A recent survey found that only 13% of older homeowners said they were likely or very likely to use a reverse mortgage. Many fear losing their homes, which is not possible under the loans. Others worry that the loans mean taking away their children’s inheritance. This last worry is legitimate. The children cannot inherit home equity that is used to pay the reverse mortgage. But most children would rather their parents use a reverse mortgage to pay for needed expenses, especially nursing home care.
But another group of seniors is making aggressive use of reverse mortgages in ways that were not contemplated when the loans were developed. Some seniors use reverse mortgages to buy second homes, make substantial improvements to their homes, travel, buy airplanes or boats, and to buy recreational vehicles.
These seniors generally set up line of credit reverse mortgages and draw on those credit lines when they decide to spend money. A unique feature of the reverse mortgage line of credit is that the amount available can increase over time as the home’s value is increasing. This can encourage using the loan for lifestyle expenses.
In the early years of reverse mortgages, most borrowers were long time widows in their late seventies. In recent years, less than half of reverse mortgage borrowers are women and the average age of the borrowers is down to the mid-seventies.
I continue to advise that a reverse mortgage be used as a last resort. Younger and more active seniors are using the loans to enhance their lifestyles, not to pay for necessary expenses. The problem with such use is the home equity will not be available in their later years should unexpected expenses, such as nursing home or in-home care, arise.
In addition, reverse mortgages are an expensive way to borrow. That is why the federal guarantee requires counseling before a loan can be issued. The counseling session is supposed to ensure that the full cost of the loan is clear to the borrower. A recent study concluded that the fees of a reverse mortgage typically are 7% to 11% of the home’s value. Closing costs themselves often are $10,000. A homeowner who uses a reverse mortgage to pay for lifestyle expenses should ensure that there are other sources to pay for the potential medical and other large expenses down the road. The homeowner also should fully understand that the reverse mortgage is an expensive way to borrow.
The federal insured reverse mortgages usually are called the FHA, HECM, or HUD reverse mortgage. (HECM stands for Home Equity Conversion Mortgage). In addition, Fannie Mae has a HomeKeeper Reverse Mortgage that also can be used to purchase a home. Lehman Brothers and Wells Fargo Bank offer jumbo reverse mortgages. These have a higher lending limit than the federally insured plans and are not insured.
AARP has good materials on reverse mortgages at www.aarp.org/revmort.
Additional information is at www.reverse.org. Both sites also have online
calculators that allow you to estimate the maximum amount you can borrow.
Different types of reverse mortgages are described at www.financialfreedom.com.
Lists of counselors are available from the federal Department of Housing and
Urban Development and from AARP.